2013 Index of Economic Freedom: No Boost in Trade Freedom

Abstract:The Heritage Foundation has been tracking and ranking trade freedom around the world since 1995. The rankings have consistently shown a correlation between trade freedom and improved lives for people around the world—and vice versa. The latest rankings, in the forthcoming 2013 Index of Economic Freedom, once again confirm that connection. For that reason, it is a matter of concern that the worldwide trade freedom score has not improved over the past year. The United States used to be a free trade leader, serving as an example to other countries. It can, and should, be a leader again. This Special Report describes which trade policies are helpful, which are harmful, and what the U.S. Congress can do now to put the U.S. back on a path to free trade leadership.

The latest rankings of trade freedom around the world,[1] developed by The Heritage Foundation and The Wall Street Journal in the forthcoming 2013 Index of Economic Freedom,[2] once again demonstrate how citizens of countries that embrace free trade are better off than citizens of countries that do not. The case for pending trade agreements, such as the Trans-Pacific Partnership and Africa’s Continental Free Trade Area, is bolstered by international statistics showing a strong correlation between trade freedom and a variety of positive indicators, including economic prosperity, low poverty rates, and clean environments.

Worldwide, the average trade freedom score remained unchanged from 2012, at 74.5 of a possible top score of 100. Although trade freedom remains at the second-highest level since The Heritage Foundation began tracking it in 1995, it is troubling that progress has stalled in recent years.

Trade freedom scores have shown significant improvement since 1995, when the inaugural Index of Economic Freedom was released, but there is plenty of room for additional improvement.

Trade Volume on the Rise

According to the World Trade Organization (WTO), trade volume has recovered strongly from the global recession. The volume of world trade dropped by $3.6 trillion from 2008 to 2009, but in the next two years rebounded by $5.7 trillion to record-high levels.[3] However, the WTO recently lowered its projections for continued trade growth to a 2.5 percent increase in 2012, and a 4.5 percent increase in 2013. These downgrades were due not to increases in protectionist trade barriers, but to a variety of troubling economic events, including the debt crisis in Europe, slower economic growth in China, and continued weak levels of output and employment in the United States.[4]

Positive Trade Policy Developments

Several positive developments in trade policy are taking place around the globe. Canada is unilaterally phasing out tariffs on more than 1,500 materials used by the country’s manufacturers.[5] Cutting tariffs on such inputs will make Canada’s manufacturers more competitive, providing a simple example of how countries can strengthen their economies by reducing or eliminating tariffs.

Many African countries are pursuing a Continental Free Trade Area (CFTA) modeled after other successful continental trade deals, such as the North American Free Trade Agreement (NAFTA) and the European Common Market. One study found that such an agreement would boost intra-African trade by as much as 22 percent.[6]

The United States and 10 other countries[7] are engaged in Trans-Pacific Partnership (TPP) talks. If successful, the agreement will lower trade barriers between these Pacific Rim nations while allowing additional countries to easily join in the future. The TPP’s strategic importance extends beyond the current negotiations because it will set a precedent for global trade rules for years to come. Unfortunately, difficult issues remain, including for the U.S., which is under pressure to liberalize trade in products such as clothing, shoes, and sugar.[8] If the agreement is comprehensive, the talks offer the opportunity for long-term reductions in global trade barriers.

Negative Trade Policy Developments

According to an analysis of trade policy by Global Trade Alert (GTA), an independent trade-monitoring group, there has been a significant increase in protectionist trade measures around the world. GTA found a 36 percent increase in protectionist measures implemented in 2010 and 2011.[9] Since November 2008, the number of trade-restricting discriminatory measures exceeded the number of trade-liberalizing measures by more than three to one.

GTA’s conclusion that the number of protectionist measures has increased is consistent with the Index of Economic Freedom’s conclusion that trade freedom is stuck in neutral. The GTA critique counts items such as the number of anti-dumping actions initiated, which may also affect the non-tariff barrier penalty assessed in the Index. However, the biggest factor in the Index trade freedom score is a country’s overall weighted average tariff rate, which may not be significantly affected by protectionist anti-dumping measures.

Understanding the Benefits of Trade

A comparison of the countries with the best trade scores in the 2013 Index of Economic Freedom with those that have the worst scores demonstrates the importance of trade freedom. Countries with the most trade freedom have higher per capita incomes, lower incidences of hunger in their populations, and cleaner environments.

American special interest groups often complain that “unfair” foreign competition destroys jobs at home, but in the United States, the trade deficit and the unemployment rate usually have an inverse relationship: When the trade deficit increases, the unemployment rate decreases, and vice versa. For example, in 2009, the U.S. trade deficit shrank by 46 percent, and the unemployment rate increased by 60 percent.[10]

Many critics of trade deals such as NAFTA and the WTO agreement argue that free trade benefits big multinational corporations and “the rich” at the expense of everyone else. In fact, poverty rates are much lower in countries with low trade barriers than in those where trade is restricted.[11]

U.S. Trade Leadership Needed

International trade plays an increasingly significant role in the economies of the United States and other countries. Since 1960, trade as a percentage of gross domestic product (GDP) for the world has doubled. Trade as a percentage of U.S. GDP has nearly tripled, but remains lower than the world average due to the large U.S. internal market.[12]

Historically, the United States has led efforts to expand global trade freedom. Since 1980, U.S. tariff rates have dropped by 58 percent, and tariffs in other countries have fallen an average of 50 percent just since 1998.[13] With the U.S.–Canada free trade agreement and then NAFTA, the United States initiated a healthy global contest to see which country can sign the most free trade agreements.Today, 239 regional trade agreements are in force, and dozens more are currently being negotiated.[14]

Thanks to U.S. leadership in the Uruguay Round trade talks, 123 countries collectively implemented the largest global tax cut in history and created the World Trade Organization to mediate trade disputes. Trade disagreements that could have escalated into trade wars in the past can now be moderated by impartial referees.

By eliminating U.S. quotas on textiles and apparel in 2005, the U.S. government allowed America’s poorest citizens more access to affordable clothing. And, by offering people in developing countries more opportunities to do business with the U.S., they gained an alternative to dependence on foreign aid.

Unfortunately, the long delays by the Obama Administration in implementing the Colombia, Panama, and South Korea free trade agreements effectively destroyed momentum for trade liberalization in the United States. A much ballyhooed pivot to Asia has only increased attention on excessive U.S. posturing on environmental standards and labor regulations in connection with the negotiations of the Trans-Pacific Partnership, not to mention U.S. foot-dragging on long-standing U.S. protectionism in dairy, sugar, and textiles.

Excessive Federal Spending and Trade Policy

The U.S. trade deficit has led some Members of Congress to call for new trade barriers, but they would better serve their constituents by restraining excessive government spending and the resulting federal budget deficit. The government recently announced that it is expected to run a budget deficit of more than $1 trillion for the fourth straight year. One often-overlooked result of these large budget deficits is their negative impact on U.S. exporters.

Sales of U.S. Treasury securities to foreigners are not counted as exports. If they were, Treasury securities would be one of the country’s biggest exports.

The government sold $216.5 billion in Treasury bonds to foreigners in the first five months of 2012. That is four times more than the amount exported by U.S. agricultural producers and three-and-a-half times more than the amount exported by carmakers.

Sales of Treasury securities abroad have an impact on exporters because someone who spends a dollar on a U.S. government Treasury bond has less money left to spend on U.S. private-sector goods and services.

That is why, if politicians are serious about boosting U.S. exports, their top priority should be to restrain excessive federal spending.[15] This would reduce the budget deficit, resulting in fewer Treasury bond “exports” and more opportunities for U.S. private-sector producers to sell their goods and services abroad.

How the U.S. Can Show Trade Leadership

Whatever the outcome of the presidential election on November 6, the United States can take several practical steps to encourage trade freedom.

The United States should encourage other countries’ efforts to reduce trade barriers, including African countries’ proposed CFTA. U.S. programs, such as laid out in the Generalized System of Preferences, African Growth and Opportunity Act, and the Andean Trade Preference Act, promote mutually beneficial trade and growth. These programs should be expanded to include more categories of imports and extended on a long-term basis.

In recent years, the United States has remained on the sidelines while other countries have aggressively moved forward with trade deals modeled on U.S. agreements, such as NAFTA. The Administration should get back in the game by exploring multilateral opportunities to reduce trade barriers in the Pacific, in the Western Hemisphere, across the Atlantic, and anywhere else it can find willing partners. Negotiation of a free trade agreement between the United States and the European Union would be a positive step.[16]

However, the United States need not wait for long and uncertain negotiations to reduce its own self-destructive trade barriers. Congress can take the first steps by:

Eliminating tariffs on imported shoes and clothing. These tariffs, which have been called America’s most regressive tax, cost Americans billions of dollars per year.[17]

Eliminating restrictions on sugar imports. Sugar tariffs are the modern version of the Molasses and Sugar Acts, which contributed to the American Revolution. They should be as offensive to lawmakers today as they were to colonists in the 1700s.

Eliminating job-killing anti-dumping laws. These laws reduce competition and increase the price of inputs for U.S. producers.[18] At the very least, the government should conduct a cost–benefit analysis before considering any new anti-dumping duties.

Eliminating “Buy American” laws. Requirements for governments at the state, local, and federal levels to use domestically produced products when lower-priced imports are available increase government spending, leading to higher taxes or larger budget deficits. They also indirectly limit opportunities for competitive U.S. companies to sell their products to other governments.

Eliminating the Merchant Marine Act of 1920 (Jones Act) and the Passenger Vessel Services Act of 1886. These laws require ships moving from one U.S. port to another to be U.S.-made and U.S.-crewed, thereby artificially increasing cargo transportation costs.

Conclusion

The Heritage Foundation’s 2013 rankings of trade freedom show that people in the United States and around the world benefit when their governments allow them to trade freely. Reducing trade barriers in the United States and in other countries would generate beneficial results including less poverty and greater prosperity for the 7 billion people across the globe.

—Bryan Riley is Jay Van Andel Senior Analyst in Trade Policy in the Center for International Trade and Economics (CITE) and Ambassador Terry Miller is Director of CITE and Mark A. Kolokotrones Fellow in Economic Freedom at The Heritage Foundation.

Appendix: Methodology

The trade freedom scores reported in this paper are based on two inputs: trade-weighted average tariff rates and non-tariff barriers (NTBs).

Different imports entering a country can, and often do, face different tariffs. The weighted average tariff uses weights for each tariff based on the share of imports for each good. Weighted average tariffs are a purely quantitative measure and account for the basic calculation of the score using the equation

where “Trade Freedomi” represents the trade freedom in country i, “Tariffmax” and “Tariffmin” represent the upper and lower bounds for tariff rates, and “Tariffi” represents the weighted average tariff rate in country i. The minimum tariff is naturally zero, and the upper bound was set as a score of 50. An NTB penalty is then subtracted from the base score. The penalty of 5, 10, 15, or 20 points is assigned according to the following scale:

Penalty of 20: NTBs are used extensively across many goods and services and/or act to impede a significant amount of international trade.

Penalty of 15: NTBs are widespread across many goods and services and/or act to impede a majority of potential international trade.

Penalty of 10: NTBs are used to protect certain goods and services and impede some international trade.

Penalty of 5: NTBs are uncommon, protecting few goods and services, and/or have very limited impact on international trade.

No penalty: NTBs are not used to limit international trade.

Both qualitative and quantitative information is used to determine the extent of NTBs in a country’s trade policy regime. Restrictive rules that hinder trade vary widely, and their overlapping and shifting nature makes it difficult to gauge their complexity. The categories of NTBs considered in the trade freedom penalty include:

Direct government intervention: subsidies and other aids; government industrial policy and regional development measures; government-financed research and other technology policies; national taxes and social insurance; competition policies; immigration policies; government procurement policies; state trading, government monopolies, and exclusive franchises.

An example: In 2013, France received a trade freedom score of 81.8, based on the weighted average tariff of 1.6 percent common to all European Union countries. The tariff yields a base score of 96.8, but the existence of significant French NTBs reduces the nation’s trade freedom score by 15 points.

Gathering data on tariffs to make a consistent cross-country comparison can be a challenging task. Unlike data on inflation, for instance, countries do not report their weighted average tariff rate or simple average tariff rate every year. To preserve consistency in grading trade policy, the authors use the World Bank’s most recently reported weighted average tariff rate for a country. If another reliable source reports more updated information on a country’s tariff rate, the authors note this fact and may review the grading if there is strong evidence that the most recently reported weighted average tariff rate is outdated.

The World Bank produces the most comprehensive and consistent information on weighted average applied tariff rates. When the weighted average applied tariff rate is not available, the authors use the country’s average applied tariff rate; and when the country’s average applied tariff rate is not available, the authors use the weighted average or the simple average of most-favored-nation (MFN) tariff rates.[19] In the very few cases in which data on duties and customs revenues are not available, the authors use international trade tax data instead.

In all cases, the authors clarify the type of data used and the different sources for those data in the corresponding write-up for the trade policy factor. Sometimes, when none of this information is available, the authors simply analyze the overall tariff structure and estimate an effective tariff rate.

The trade freedom scores for 2013 are based on data for the period covering the second half of 2011 through the first half of 2012. To the extent possible, the information considered is current as of June 30, 2012. Any changes in law effective after that date have no positive or negative impact.

Finally, unless otherwise noted, the authors used the following sources to determine scores for trade policy, in order of priority:

The World Bank, World Development Indicators 2012 and Data on Trade and Import Barriers: Trends in Average Applied Tariff Rates in Developing and Industrial Countries, 1981–2009;

The World Trade Organization, Trade Policy Review, 1995–2012;

Office of the U.S. Trade Representative, 2012 National Trade Estimate Report on Foreign Trade Barriers;

The World Bank, Doing Business 2011 and Doing Business 2012;

U.S. Department of Commerce, Country Commercial Guide, 2009–2012;

Economist Intelligence Unit, Country Report, Country Profile, and Country Commerce, 2008–2011; and

[2]The 2013 Index of Economic Freedom will be published in January 2013. The trade freedom rankings, which account for 10 percent of a country’s overall economic freedom score, were originally released on October 25, 2012 at the request of the Millennium Challenge Corporation, which uses them as part of its criteria for determining countries’ eligibility for grants, and were revised on November 2, 2012.

[10]Bureau of Labor Statistics, “Labor Force Statistics from the Current Population Survey: Where Can I Find the Unemployment Rate for Previous Years?” February 3, 2011, http://www.bls.gov/cps/prev_yrs.htm (accessed October 16, 2012), and Bureau of Economic Analysis, “International Data: International Transactions,” 2008–2009, Table 1, “U.S. International Transactions,” http://www.bea.gov/iTable/iTable.cfm?ReqID=6&step=1 (accessed October 11, 2012).

[19]The most-favored-nation tariff rate is the “normal” non-discriminatory tariff charged on imports. In commercial diplomacy, exporters seek MFN treatment—that is, the promise that they will be treated as well as the most favored exporter. The MFN rule requires that the concession be extended to all other members of the World Trade Organization. MFN is now referred to as permanent normal trade relations (PNTR).

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